The Financial Sector in Developing and Emerging Economies Flashcards
What is the role of saving and investment in promoting economic development?
Economic growth in its self doesn’t guarantee economic development but it is a necessary ingredient. Since long run economic growth is the expansion an increase in aggregate supply investment has large importance as it increases a countries productive capacity.
Since many firms finance investments with loans, a substantial amount of saving must be happening so the bank has funds that it can loan to these banks.
What is the Harrod- Domar model?
That GDP is determined by the savings ratio and the capital output ratio. Essentially, saving is necessary and these savings must be able to be transformed into productive investment
What is the savings ratio?
That GDP is determined by how much an economy can save.
What is the capital-output ratio?
Economic growth is determined by how productive investment is.
The amount that has to be spent to increase national output by a unit.
What are the steps of economic development as according to the Harrod - Domar model?
People save- Which enables investment- Investment allows capital to increase and technology to be improved.
This leads to an increase in output and incomes which leads to an increase in saving according to (Marginal propensity to save) and the cycle begins again.
Why might the Harrod- Domar model fail to work smoothly?
The model theorises that saving is the key to economic development as otherwise investment will be limited, however the flow of savings may be limited in LDC’s as people may prioritise spending their money on resources of consumption
What is the equation for the Harrod- Domar Model?
Growth rate of output= Savings ratio/ Capital- output ratio. pg 335
Why might it be difficult for savings to accumulate in an LDC?
Many LDC’s have undeveloped financial institutions so if people want to save they can’t do so in a savings account in a bank, instead they save “under the bed”. This money doesn’t easily transfer into loanable funds.
Why can lowering the interest rate reduce investment?
Governments may lower the interest rate to encourage firms to borrow to incentivize investment, however they are forgetting that low interest rates can reducing saving meaning there are less loanable funds. This would mean firms wan to invest but don’t have the funds to do so.
Why might savings not be converted to investment in an LDC in terms of lack of the entreperneurial factor of production?
There needs to be entrpreuneurs that can identify investment oppurtunities and have the skills to carry them through and willingness to take risks.
Why may investment not be productive in LDC’s
The firms need physical capital in order to increase how much they produce, they may have to import capital however this is not always possible when there is a foreign exchange gap.
What’s a foreign exchange gap?
When an LDC is unable to import the goods that they need for development because it has a shortage of foreign exchange. Essentially they don’t have enough of other currencies.
What can countries do to increase their foreign exchange?
When foreigners buy a countries exports we gain their currency.
What is the convergence process?
LDC’s that are beginning to develop adopt technology that has already been used and tested so grow at a more rapid rate than already developed economies.
What is the argument against the convergence process?
Many LDC’s don’t have satisfactory human capital, the education system isn’t good enough, the health care is subpar and this makes investment less productive.
What are other external ways that investment can be financed apart from domestic savings.
Higher income countries may give flows of overseas assistance, meaning banks have more loanable funds and are more willing to loan to firms.
The LDC may be able to borrow from international capital markets to finance domestic investment.
Multi-National corporations may be persuaded to engage in foreign direct investment.
What is the drawback to an LDC’s domestic investment being funded by overseas flows from higher income countries?
These flows are often seen as part of trade policy, in that the other countries expects imports from the LDC such that the LDC looses out as they are giving more than they are receiving.
What is the drawback to a LDC receiving FDI from a multinational
Often with the MNC, profit made is not recycled in the economy, often it leaves and goes to the source country of the MNC.
What is the drawback to a LDC participating in international borrowing.
The loan has to be paid back eventually and LDC’s may find themselves burdened by debt that they can’t afford to repay.
Why do people in LDC’s often struggle to gain the funds needed for small scale projects
There is some market failure in rural credit markets.
Many people in rural areas can’t access the formal finance sector as there is an absence of branch banking and internet banking.
Why do loans in the informal credit market often have extremely high interest rates?
There is a very high risk premium and money lenders may not have the means of finding out information on the borrower to assess their likelihood of defaulting.
A moneylender might have a monopoly in the village giving people no other choices of gaining credit.
What is microfinance?
As a solution to the difficulty of people in rural areas of LDCs to access the formal financial sector, schemes have been created to provide finance for small scale projects.
What is the Grameen Bank?
Originating in Bangladesh, it is a bank that made small loans to small groups of women that would otherwise have to rely on moneylenders. Each group was made responsible for paying back the loan.
How successful was the Grameen Bank at supporting economic development?
The loans have been seen to raise income as they charge an interest rate that is close to that of commercial banks, far below what money lenders charge. This enables the women to make greater profit.
This has also increased food consumption, and citizens having enough to eat is a key part of economic development.
Overall living standards have also increased due to the rise of income
Grameen-type credit programmes are now operating in 59 countries across Africa, South-America, Asia and Europe.
